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Thursday, January 14, 2016

Role of Market Supply During Housing Crash

Many people ask me over and over whether stock on market, unemployment, or vacancy rates need to spike before house prices start falling. That thinking seems to be valid but only if someone assumes that supply side is what drives prices up during boom times. I already covered this issue before but I want to be more clear.

We can look into three indicators to get better understanding of this issue, stock on market (number of homes for sale), rental vacancy rates and number of sales. We'll also look what happened in USA because one of the main arguments for such claims are based on understanding that high foreclosure rate pushed US houses prices down.

Let's have a look in US house prices:
US house price index
 Prices peaked in late 2005, by the end of 2007 were down  20% and by end of 2008 they reached -40%. In some bubbly areas magnitudes were larger (e.g. Phoenix AZ -40% by end of 2007, -75% by the end of 2008) but timing was very similar.

The main question here is: why?
Some people say unemployment rise:

US unemployment

They are wrong. Unemployment was at multi-decade lows at the end of 2007 at what time house prices already lost half of their total losses (20% on average 40% in some cities). Even by the end of 2008 unemployment was still relatively low (under 6%) while by that time house prices fell almost to the bottom.

Some people say subprime mortgage delinquency and foreclosures:

In late 2005 when house prices peaked mortgage delinquency and foreclosures were close to the record lows while  By the end of 2007 the spiked to levels not much different to historic lows. By the end of 2008 reached levels 30% over 2002 levels. There is clear correlation between prices and foreclosures but not causation. It seems that foreclosures were behaving similar or slightly lagging in time behind prices. It's unlikely that foreclosures caused house price to fall since they were  as often during boom 2002 when prices jumped 10% and 2007 when prices fell by 20%.

Let's see oversupply - new home construction:

Construction was rising and it peaked in late 2005 at the same time as prices peaked. It fell fast afterwards and by end of 2007 was down 60%. Falling construction clearly didn't cause prices to fall during the bust. Maybe construction was so great during boom years with huge unsold inventories that later forced prices down. So, let's see if there was an oversupply of all homes - stock on market:

Number of homes for sale was rising with house prices during bubble period. It peaked in 2006 at the same time house prices peaked but than it fell with house prices. It is hard to argue that falling stock on market was driving price drops. Stock on market was above 'normal' and rising during 2000-2006 period when prices were going up. During house price collapse period 2007-2009 stock on market fell by more than 50% - clearly not driving prices down. If there was a large number of unsold new homes prior to bust they would have appear on market afterwards. The same is case with foreclosures. Despite all of this stock on market was falling with house prices.

Some people say that oversupply went into rental market:

Rental vacancy rate peaked in early 2004 when prices were booming and reached a decade low at the end of 2007 when prices already lost 20%. It's hard to imply that oversupply of homes ended up on rental  or that falling rental vacancies pushed prices down.

So if it's not unemployment forcing people to sell, nor foreclosures, nor oversupply (new construction, rising vacancy rates or rising stock on market). It's clearly not increased supply so what is it?

We should look into demand side. House price growth in years prior to 2006 was driven by price speculation, prices were rising because they were rising. Property investors were ready to pay more because they expected further growth and capital gains, occupiers were speculating that prices will be going up so it's better to jump in at any price or miss out forever. Demand was booming and it was supported by easy credit.

Number of new sales:

Number of new home sales peaked in early 2005 before house prices peaked and fell quickly to levels not seen in decades. Demand for new homes collapsed prior do price falls. How about existing homes?

Let see how it all aligns together:

In late 2004 sales peaked while prices and number of homes for sale continued rising. Around 6 months later prices peaked while stock on market continued to rise. Prices started falling at slow rate. In late 2006 stock on market started falling while number of sales continued down - and prices started plummeting despite fall in supply. Falling demand (fall in number of sales) is the only indicator leading house price fall.

12% vacancy rate in USA is not comparable to our vacancy rate because they count all rental homes that are vacant while dodgy sqm only counts those listed on one or two websites for more than 3 weeks continuously. In addition rental market in USA operates differently, largest share of rental homes is owned by businesses which makes normal vacancy rate high - over 7.5% (currently USA is experiencing rental crisis with rents skyrocketing while rental vacancy rate is over 7%)  In 2006-2008 period vacancy rate was just slightly over at around 9.5% and it peaked at 11% well after house prices collapsed in 2009.

Stock on market at the peak was significantly lower (0.5% of all homes) compared to current and historical numbers in Australia (~3% of all homes). Many of sellers in Australia are trying to get good price and they will not sell for less at the moment.  But when demand collapses  there is always enough supply (people who need or want to sell regardless of market conditions) to drive prices down on low volumes (US home prices collapsed in 2006-2009 period on record low volumes not seen since WWII). It only takes a few sellers willing or forced to accept anything to push prices into the ground.

Sydney sale volumes peaked (current cycle) in mid 20014, Melbourne in mid 2015, nationally it is probably peaking around this time, ...

Saturday, May 23, 2015

Australian Housing time has come ...

Based on debt levels, economic conditions, mining bust and finally google trends data (see my previous post) I predict that peak price will be reached within 6 months. It will be followed by, at the beginning, slow decline over 6-12 months and than accelerated collapse.

Google Trends - "housing bubble" in Australia

Saturday, November 2, 2013

"Bubble Truths" and "anxiety about overpriced housing is overblown"

An article from the mainstream media brought interesting insight into a "bubble mind". In an interview, one of the famous Australian economists Stephen Koukoulas (with over more than 25 years of professional experience as an economist in government, as Global Head of economic and market research, a Chief Economist for two major banks and as economic advisor to the Prime Minister) asked simple question:
''What would you prefer? House prices three times' average incomes with 13 per cent interest rates or house prices four or five times' average incomes with interest rates under 7 per cent?
''The bottom line is the repayments are roughly the same.''
Economics used to be a science, not opinion field, so lets see how good scientist one of the Australian most famous economists really is.

According to RBA 1982 was the last year when Standard Variable interest rate was 13% and ratio between an average house price and average income was 3. An average repayment after purchase was 33% of the income (25 year loan, 80% LVR, deposit equal to 60% of annual income). 

Today, ratio between an average house price and average income is around 7 (according to RBA). Standard variable interest rate is 5.95%, repayment 45% of income (30 years loan, 90% LVR, deposit 70% of annual income).

First year repayment today is 36% higher than what it was when home prices were 3 times income and IR 13%.

But that is not the end of the story. Houses take decades to repay, so let see how repayments change over time.

In year 2, repayment was equal to 29% for 1982 buyer (IR dropped to 12.5%, income grew by 9%), and 43.5% for today's buyer (assuming IR and income growth stay the same). 

In year 3, repayment dropped to 25% of income for 1982 buyer (IR dropped to 12%, income grew by 11%) and 41.5% of income for today's buyer (assuming IR and income growth stay the same).

In year 4, repayment dropped to 23% of income for 1982 buyer (IR dropped to 11.5%, income grew by 5%) and 40% of income for today's buyer (assuming IR and income growth stay the same).

In year 5, repayment dropped to 21% of income for 1982 buyer (IR increased to 12%, income grew by 7%) and 38.5% of income for today's buyer (assuming IR and income growth stay the same).

Total cost of house ownership (including deposit) in first 5 years was 190% of income for 1982 buyer and 280% for today's buyer. Despite significantly lower rates, higher LVR and longer loan term, houses today are 47% more expensive in first 5 years than they were in 1982.

Over the life time of a mortgage (25 vs 30 years), today's potential buyer (with assumption that rates stay low) would pay more than twice in income terms for an average house than buyer from 1982.  

Economist Stephen Koukoulas says the anxiety about overpriced housing is overblown because the burden of today's big home loans has been completely offset by the saving from low interest rates.

Completely offset?
Don't worry and buy because "anxiety about overpriced housing is overblown"?!

Monday, February 18, 2013

What caused Housing Bubbles in UK

UK has recorder one of the most volatile house prices in the West since WWII. Many economists use UK as a prime example how "land restrictions cause housing bubbles".  But you they failed to provide evidence that UK home price volatility is caused by land restrictions and not something else. 
They overlooked the fact that beside tough land restrictions UK has the least stable and the most speculative banking system in the West. Maybe that has something to do with price volatility. Lets explore:  

If we look into history of UK banking you will find very interesting correlation between banking regulation changes and housing bubbles. 

Home prices in UK were relatively stable during 50s and 60s. Prices were slowly going up while government was slowly introducing "land development restrictions" in 1960s. This price growth could be attributed to land restriction regulation in addition to other causes (real income growth, etc.).

Suddenly, after decades of stability, house prices spiked in early 70s. Interestingly, that happened immediately after significant bank deregulation process: Competition and Credit Control in 1971 and big bank mergers in late 60s (during just two years in 1968, five big bank mergers occurred) . Competition and Credit Control relaxed bank reserve requirements, allowed deposit banks to participate on the market, removed interest rate collusion ... More interestingly, in 1970 (just before the bubble) new conservative government started relaxing many of the land development restrictions introduced by labour in decade before. Bubble burst and prices drop by 30% by mid late 70s. During this period of falling prices new labour government introduced new and tougher land restrictions but that didn't prevent house prices from falling.

Than, in late 70s, foreign exchange controls were lifted and 1979 Banking Act was passed. That coincided with the housing bubble that peaked in early 80s. This bubble was much smaller but real prices fell almost 20% after the burst. 

New conservative government started reforms that included removal of some land restrictions laws and big banking reform. In mid 80s ‘Big Bang’ reforms were passed (1986). These reforms caused expansion of  building societies and relaxation of lending standards. Deregulation turned building societies into real banks and enabled them to lend money freely. This was followed by big housing bubble of late 80s.   

Finally, world wide deregulation and globalisation of late 90s happened just before great housing bubble of 2000s. Lending standards were dropped, bank funding became obscure and credit issue relaxed. UK banking sector tripled in less than a decade. Speculations became global, included insurances, big funds ...    

This clearly shows that every UK housing bubbles since WWII occurred after a new bank regulation rules were passed (almost identical causation can be showed for USA, Australia ...). In some instances lend restrictions rules had been lifted before bubbles started inflation. These relaxations of land restrictions failed to prevent bubbles from happening.    

In addition, the theory that land supply restrictions cause house price volatility is very hard to apply on UK cities where population significantly declined over the last 40 or 50 years (Manchester, Liverpool, Sheffield ...). These cities did not require much of a new land to meet new demand, still prices were more volatile there than in cities with fast growing population and end even more land restrictions like London.

- Richard Davies, Peter Richardson, Vaiva Katinaite and Mark Manning of the Bank of England - Evolution of the UK banking system - 2010
- Peter Scott - The Property Masters - Taylor & Francis - 2013

Monday, November 19, 2012

Post-construction boom plan?

There is a lot of talk recently about RBA's new great idea of replacing the mining boom with a construction boom. It is quite possible that could work, and we continue growth by shifting ex-mining investments into housing construction. This is not new idea. It was very "successfully" implemented in quite a few places around the world recently. Irish and US governments successfully replaced IT boom of late 90s with period of steady growth driven by construction boom. Chinese government partially did the same thing after their export boom ended. Historically, it seems it's quite easy to succeed with this plan.

BUT, there is one much more important question that nobody seems to be asking  in Australia: even if the great idea of construction boom replacing mining succeeds, what will replace construction boom at its end in three or five years? 

If everything goes as planed, in just 5 years we will have million more homes - half of them empty (around half a million more new homes than new households), we will have around half a trillion more debt (half a trillion less invested in productive business and infrastructure) Maybe we can continue doing the same for 5 more years after. By than we should have million more empty homes and trillion more in debt.

BUT, what will happen after we take more debt and misallocate it into more empty houses? What is the great idea promises us after?

I'm scare even to think about this.
I hope our government's great ideas fails quickly. I hope for that not because I think we will be fine if it fails (we will not), but because I'm sure in 5 years we will be much better than if they succeed. For majority of Australians (especially our kids) going into few years long recession in 2013 is much better option than going into decade long deep depression in 2018.

I hope, we learned something from other's mistakes.

Thursday, June 21, 2012

Census and Australian housing shortage/oversupply

Preliminary Census data is published a few days ago - census link, and as I expected it just confirmed some of my projections.

 First, couple of general (non housing) findings:

  • Total population increased to 21.5m, while total number of dwelling increased to 9.1m.
  • Population growth over the last 5 years was lower than projected (around 300k less – 60k less per year)
  • Household size remained stable at 2.6
  • 65+ is the fastest growing population group
  • Median household income was $64k

Housing data is also interesting.

Ownership rate decreased from 68.1% to 67%. Outright ownership decreased from 34% to 32.1%. Percentage of mortgage owners and renters who spend more than 30% of income on housing increased as well. Income increased only 20% while house prices increased 33.3%, and median mortgage repayment 38% over the previous 5 years. Although income and repayment census data is not very reliable, this suggests that housing became less affordable.

Percentage of unoccupied dwellings increased from 10.4% to 10.7%. Total number of households increased by 616k; number of private dwellings increased by 720k. More than 100k dwellings that were built since 2006 are not occupied. One new dwelling was built for every 2.3 new residents while average household size stayed 2.6.

All this suggests that there is no housing shortage in Australia. In fact, it suggests that oversupply of homes increased in 5 years. The oversupply increase since 2006 seems to be higher than what I predicted here. The likely reasons for this are wrong population growth estimates and my methodology that tends to underestimate oversupply. This means that current oversupply most likely exceeded one million homes.

Oversupply of homes is significantly up, price to income ratio is up, demography is getting worse, …  It seems that there is nothing about real demand and supply that can drive house prices up (or support current prices). It is all down to speculative demand and credit availability. 

Friday, April 13, 2012

Why we are so different - according to RBA

RBA head of financial stability, Luci Ellis, delivered few days ago a speech at Financial Markets Conference in Atlanta. Ms Ellis “explained” why the US housing market bubbled and then busted, and why the Australian housing market will not burst. She made several arguments why we are different. All of them wrong. I will concentrate here on two points:
The first is that housing supply is quite elastic here, at least in enough parts of the country to matter. The housing boom was a construction boom as well as a price boom. As a result, by 2006 there was already a substantial overhang of excess supply (Graph 1).  The inherent stock-flow interaction in the housing market means that construction booms sow the seeds of their own destruction. Prices can undershoot formerly sustainable levels.  
US construction in 2000s was (in nominal terms) lower than in 1970s and 1980s. In relative terms (relative to population or total existing housing stock) construction rate at the peak in mid 2000s was by far lower than in all previous decades.

Posted Image

This is what she calls US “construction boom”. During the same period we were building at the rate of almost 2%.

More interestingly, in states where developments were restricted construction “boom” was lower while bubble was bigger. Supply side restrictions just amplify house price growth but don’t stop prices from falling. Places with the most supply restrictions (Las Vegas, California …) recorded largest house price drops although none of supply restrictions was lifted in meanwhile. Places with no restrictions like Texas or Georgia recorded no price growth.

This links to the third factor, which is that a range of tax and legal differences, as well as industry convention, created a system that discouraged amortisation. Interest-only loans, explicitly negative amortisation loans and cash-out refinancing, all meant that loan-to-valuation ratios that were high at origination, stayed high well into the life of the loan. American households are less likely to pay their mortgages down ahead of schedule than Australians (Graph 2). Trade-up buyers seem to have high loan-to-valuation ratios in the United States; that doesn't appear to be true in Australia. The result of all this is that the US housing stock is far more leveraged than that in Australia, even during the boom period (Graph 3).

While it's true that Australia does not provide tax benefits for PPOR mortgages it provides significant benefits for property investments. Americans have interest in not paying mortgages ahead of schedule, while Australians don’t. Even with this “advantage” Australians managed to increase LVR during housing boom while Americans decreased it. Australians were adding more debt and much faster (relative to home prices) than they are able to repay ahead of schedule. So, we are paying mortgage faster but or those mortgages grew so quickly that debt is skyrocketing.

Posted Image

Australia has higher percentage of interest only loans which shows that less people in Australia are interested in owning house – these people only think about price speculation. Since boom started we increased out leverage by almost 50% while Americans decreased their leverage during boom years (by almost 10%). After house price fell US leverage jumped up to level almost 50% higher than pre-boom levels. When our bubble bursts leverage will jump to levels at least 150% higher than  pre-boom period (probably 200% or even more). It’s already 50% up.

RBA is already left with very little credibility and this is just one more step toward losing all of it.

Wednesday, February 8, 2012

Market Inventory vs Bubble Burst

There is strong belief among Australians that housing market will not crash because majority people will not be willing or forced to sell for reduced price. Although it is true that majority of people will not sell at low price, there is misconception how many forced or willing sellers is necessary to crash the market.

Let's see behaviour of market stock in Australia over the past 5 years or so:

Chart1 Stock on the market RPdata
 From the chart, we can see that number of homes for sale doubled since first housing troubles started in 2008. Stock slightly decreased during short boom in late 2009 - early 2010 but increased 50% since then. Similar data comes from SQM - Chart 2
Chart2 - Stock on the market SQM
 From observation of a recent events in USA, I noticed that significant rise in inventories is not needed for price to crash. If we take a look at US existing house inventories (Chart 3) we can clearly see that inventories didn't increased more than inventories in Australia.
Char3 - US existing home inventory

From the chart we can see that home inventories in USA at the peak were lower than current inventory in Australia. At the peak inventories were only about 4% of total housing stock, while that percentage already passes 4.5% in Australia.  It is hard to say that 4% of the total stock is extreme number that caused 33% price crash in USA. We should also notice that stock on the market fell in late 2008 early 2009 when house prices dropped the most. This means there is something else that significantly affects house prices.

Lets take a look at sales:

Chart4 - US home sales
It is clear that drop in sales, significantly affected housing market in USA. Lack of buyers seems to have much larger effect on price than rise in inventories. It is expected there will always be significant number of people forced or willing (for any reason) to sell, but it's hard to expect significant number of buyers (especially if credit freezes and/or unemployment hits).

Let's see whether this holds in Australia

Chart 5 - Australia home sales
 It is clear that house price fall in 2008/2009 was caused by significant fall in sales. House prices recovered driven by new buyers although stock on market remained elevated compared to pre 2007 levels.

It looks like inventory levels at the moment are more than enough to enable market crash, it's up to buyers to set market direction. Recent drop in sales (since 2010) is larger than drop recorded in USA during the first two years of price contraction. If soon buyers do not return to the market in large numbers, we may expect price fall to accelerate. There is no need for mass panic sale for prices to fall significantly.

Sunday, December 18, 2011

What drives prices up?

There is common understanding in Australia that FHBs are one of the most important house price drivers. Is this really true?

Let's see what data shows:

Australia Property Investor/FHB market share vs. house prices

It is clear from the chart that there is a weak correlation between FHBs market share and house prices. For most of the time these two series were heading into opposite direction (correlation is slightly negative). On the other hand, property investors (PI) market share is very strongly correlated with house prices. This, of course, does not imply direct causation so we need more information. Just recently, US FED published report* that claims increase in property investors market share was the most important factor that created housing bubble in USA. Lower lending standards attracted large number of highly leveraged investors ready to take big mortgages with expectation of big and quick capital gains. They increased demand and drove prices up. FHBs and upgraders got squeezed and forced to pay ever increasing prices. Increasing prices attracted more investors and feedback started its own life independent of real demand or realistic future prospects. It's almost irrelevant what initiates the feedback loop; once started abundant and easy credit is only thing needed for growth.

According to FED property investor market share in bubble states increased from less than 25% in 2000 to almost 45% in 2006. Similar rise is property investors was recorded in Australia as a whole. In some areas (SE Qld, inner capital cities, ...) significantly higher percentage of investors entered property market and drove house prices by increasing debt to extreme levels. It is hard to imagine this trend to continue for long because of huge debt already accumulated. Once prices stop growing, property investors begin to sell because quick capital gain expectations are gone while big repayment bills continue to arrive every month. Most of highly leveraged and negatively geared investors cannot afford to hold for long without quick capital gain expectations.

Looks like same forces created housing bubbles in USA and Australia. Other minor factors made bubble extents and timings slightly different but core cause for rise and fall seem to be the same.

Wednesday, November 2, 2011

Australian House Price Trend

There have been discussions that house prices cannot remain flat in “real” CPI adjusted terms because we are earn much more in “real” terms today that few decades ago. I agree that CPI adjusted prices should not be flat because CPI adjustment does not reflect standard of living improvements over time. House prices should follow more realistic measures of our improved wellbeing.

Chart 1 shows house prices in “real” (CPI adjusted) terms as well as growth of our real per capita GDP and per household GDP. These measures are one of few only with long historical series that could be used for price “trend” estimation.

Chart 1 "Real" House Prices vs. "Real" per Capita and Household GDP

Real per capita GDP is good measure because real GDP by itself ignores the fact that more than twice as many people contribute to GDP today compared to 50 years ago. On the other hand, houses are asset needed and owned by households, not the individual persons. In addition, number of homes is closely following number of households. For these reasons, real GDP per households seems to be better measure of the increased ability of households to spend money on home.

From the chart you may see that “real” (CPI adjusted) house prices followed real GDP per household with only few smaller property bubble events in mid 70s and late 80s. Prices returned toward the real GDP per household trend soon after. Since late 90s, house prices significantly deviated from real GDP per household trend. This deviation is strong indication that we are currently experiencing big housing bubble that is not supported by fundamentals.

This chart could give us a feel how much our homes are overvalued - inflated beyond historical and fundamental trend and what level of correction we may expect in near to mid future. Correction may happen with slow deflation in real terms or quick crush. It could be even combination like it was in 1990s when prices fell quickly by 10% in “real” terms and than stagnated while real GDP per household increased.

1. ABS Australian National Accounts
2. ABS Australian Demographic Statistics
3. Stapledon
4. ABS House Price Indexes